Tuesday, October 1, 2013

George Soros on Financial Markets, the Subprime Mortgage Crisis, and the Credit Crash (2008)

During September 2008, the crisis hit its most critical stage. There was
the equivalent of a bank run on the money market mutual funds, which
frequently invest in commercial paper issued by corporations to fund
their operations and payrolls. Withdrawal from money markets were $144.5
billion during one week, versus $7.1 billion the week prior. This
interrupted the ability of corporations to rollover (replace) their
short-term debt. The U.S. government responded by extending insurance
for money market accounts analogous to bank deposit insurance via a
temporary guarantee[180] and with Federal Reserve programs to purchase
commercial paper. The TED spread, an indicator of perceived credit risk
in the general economy, spiked up in July 2007, remained volatile for a
year, then spiked even higher in September 2008, reaching a record 4.65%
on October 10, 2008.

In a dramatic meeting on September 18,
2008, Treasury Secretary Henry Paulson and Fed chairman Ben Bernanke met
with key legislators to propose a $700 billion emergency bailout.
Bernanke reportedly told them: "If we don't do this, we may not have an
economy on Monday." The Emergency Economic Stabilization Act, which
implemented the Troubled Asset Relief Program (TARP), was signed into
law on October 3, 2008.

Economist Paul Krugman and U.S. Treasury
Secretary Timothy Geithner explain the credit crisis via the implosion
of the shadow banking system, which had grown to nearly equal the
importance of the traditional commercial banking sector as described
above. Without the ability to obtain investor funds in exchange for most
types of mortgage-backed securities or asset-backed commercial paper,
investment banks and other entities in the shadow banking system could
not provide funds to mortgage firms and other corporations.

This
meant that nearly one-third of the U.S. lending mechanism was frozen and
continued to be frozen into June 2009.[132] According to the Brookings
Institution, the traditional banking system does not have the capital to
close this gap as of June 2009: "It would take a number of years of
strong profits to generate sufficient capital to support that additional
lending volume." The authors also indicate that some forms of
securitization are "likely to vanish forever, having been an artifact of
excessively loose credit conditions." While traditional banks have
raised their lending standards, it was the collapse of the shadow
banking system that is the primary cause of the reduction in funds
available for borrowing.

There is a direct relationship between
declines in wealth, and declines in consumption and business investment,
which along with government spending represent the economic engine.
Between June 2007 and November 2008, Americans lost an estimated average
of more than a quarter of their collective net worth. By early November
2008, a broad U.S. stock index the S&P 500, was down 45% from its
2007 high. Housing prices had dropped 20% from their 2006 peak, with
futures markets signaling a 30--35% potential drop. Total home equity in
the United States, which was valued at $13 trillion at its peak in
2006, had dropped to $8.8 trillion by mid-2008 and was still falling in
late 2008. Total retirement assets, Americans' second-largest household
asset, dropped by 22%, from $10.3 trillion in 2006 to $8 trillion in
mid-2008. During the same period, savings and investment assets (apart
from retirement savings) lost $1.2 trillion and pension assets lost $1.3
trillion. Taken together, these losses total a staggering $8.3
trillion. Since peaking in the second quarter of 2007, household wealth
is down $14 trillion.

Further, U.S. homeowners had extracted
significant equity in their homes in the years leading up to the crisis,
which they could no longer do once housing prices collapsed. Free cash
used by consumers from home equity extraction doubled from $627 billion
in 2001 to $1,428 billion in 2005 as the housing bubble built, a total
of nearly $5 trillion over the period. U.S. home mortgage debt relative
to GDP increased from an average of 46% during the 1990s to 73% during
2008, reaching $10.5 trillion.

To offset this decline in
consumption and lending capacity, the U.S. government and U.S. Federal
Reserve have committed $13.9 trillion, of which $6.8 trillion has been
invested or spent, as of June 2009. In effect, the Fed has gone from
being the "lender of last resort" to the "lender of only resort" for a
significant portion of the economy. In some cases the Fed can now be
considered the "buyer of last resort".

George Soros was born in Budapest, Hungary, in 1930. His father was taken prisoner during World War I and eventually fled from captivity in Russia to reunite with his family in Budapest. Soros was thirteen years old when Hitler's Wehrmacht seized Hungary and began deporting the country's Jews to extermination camps. In 1946, as the Soviet Union was taking control of the country, Soros attended a conference in the West and defected. He emigrated in 1947 to England, supported himself by working as a railroad porter and a restaurant waiter, graduated in 1952 from the London School of Economics, and obtained an entry-level position with an investment bank.

In 1956, Soros immigrated to the United States, working as a trader and analyst until 1963. During that time, he developed his own theory of markets called 'reflexivity', which he has laid out in his recent books THE ALCHEMY OF FINANCE and THE CREDIT CRISIS OF 2008 AND WHAT IT MEANS. In 1967 he helped establish an offshore investment fund; and in 1973 he set up a private investment firm that eventually evolved into the Quantum Fund, one of the first hedge funds, through which he accumulated a vast fortune.

George Soros is a self-described student of Karl Popper, and strong opponent of totalitarianism. He has devoted much time to philanthropy — among other projects, founding the Open Society Institute in 1993 — and, after 2001, to US domestic politics, donating millions of dollars to Democratic candidates and liberal 527 organizations and earning political enmity in the process. Soros has published numerous books, including THE CREDIT CRISIS OF 2008 AND WHAT IT MEANS; THE AGE OF FALLIBILITY: CONSEQUENCES OF THE WAR ON TERROR (Public Affairs, 2006); THE BUBBLE OF AMERICAN SUPREMACY (2005); GEORGE SOROS ON GLOBALIZATION (2002); OPEN SOCIETY: REFORMING GLOBAL CAPITALISM (2000); THE CRISIS OF GLOBAL CAPITALISM: OPEN SOCIETY ENDANGERED (1998); SOROS ON SOROS: STAYING AHEAD OF THE CURVE (1995); UNDERWRITING DEMOCRACY (1991); OPENING THE SOVIET SYSTEM (1990); and THE ALCHEMY OF FINANCE (1987). His essays on politics,